Construction Financial Management Answers to Exercise Questions S L Tang Download free books at S.L Tang Construction Financial Management Answers to Exercise Questions Download free eBooks at bookboon.com Construction Financial Management: Answers to Exercise Questions 1st edition © 2015 S.L Tang & bookboon.com ISBN 978-87-403-0949-2 Download free eBooks at bookboon.com Construction Financial Management: Answers to Exercise Questions Contents Contents Exercise Questions for Chapter Exercise Questions for Chapter Exercise Questions for Chapter 12 Exercise Questions for Chapter 21 Economic indicator NPV and financial indicator IRR 24 Exercise Questions for Chapter 31 Exercise Questions for Chapter 36 Exercise Questions for Chapter 40 Exercise Questions for Chapter 44 Fast-track your career Masters in Management Stand out from the crowd Designed for graduates with less than one year of full-time postgraduate work experience, London Business School’s Masters in Management will expand your thinking and provide you with the foundations for a successful career in business The programme is developed in consultation with recruiters to provide you with the key skills that top employers demand Through 11 months of full-time study, you will gain the business knowledge and capabilities to increase your career choices and stand out from the crowd London Business School Regent’s Park London NW1 4SA United Kingdom Tel +44 (0)20 7000 7573 Email mim@london.edu Applications are now open for entry in September 2011 For more information visit www.london.edu/mim/ email mim@london.edu or call +44 (0)20 7000 7573 www.london.edu/mim/ Download free eBooks at bookboon.com Click on the ad to read more Construction Financial Management: Answers to Exercise Questions Exercise Questions for Chapter Exercise Questions for Chapter Exercise Question Using the company balance sheet shown on Table 2.2 of Chapter 2, calculate for each 2012 and 2011: a) the company’s equity (or net worth), b) working capital, and c) current ratio Solution: (a) Company’s equity (or net worth)   2012 Total assets   2011 14,591,105 13,772,652 9,159,760 8,078,450 5,431,345 5,694,202 Total liabilities Net worth (b) Working capital  2012 Current assets   2011 12,697,745 11,685,952 Current liabilities 7,679,247 6,177,005 Working Capital 5,018,498 5,508,947 (c) Current ratio 2012 Current assets Current liabilities = 12,697,745 7,679,247 2011 = 1.65 11,685,952 6,177,005 = 1.89 Exercise Question Based on the project data presented in the table below, calculate for each of the two projects: a) the revenue using the percentage-of-completion method, b) the gross profit to date, using the percentage-of-completion method, and c) the amount of over / under billing for each project Download free eBooks at bookboon.com Construction Financial Management: Answers to Exercise Questions Exercise Questions for Chapter Project Financial data Project A Project B Contract amount $15,000,000 $15,000,000 Original estimated cost 14,400,000 14,800,000 Amount billed to date 10,700,000 10,700,000 Payments received to date 10,900,000 10,630,000 Cost incurred to date 11,450,000 10,550,000 Forecasted cost to complete 3,000,000 4,100,000 Costs paid to date 9,400,000 9,600,000 Note: some figures are for reference only and are not useful for calculating what are asked for Solution: (a) Revenue using the percentage-of-completion method Project A % completed = Cost incurred = Cost incurred + forecasted cost = 11,450,000 10,550,000 14,450,000 14,650,000 79% = 72% Project A Revenue = Contract Amount × % completed = 15,000,000 × 72% = 11,850,000 = 10,800,000   Project A   Project B Revenue 11,850,000 10,800,000 Cost incurred 11,450,000 10,550,000 400,000 250,000 (c) Under billing   Project A   Project B Revenue 11,850,000 10,800,000 Amount billed 10,700,000 10,700,000 Under-billing 1,150,000 100,000 Download free eBooks at bookboon.com Project B 15,000,000 × 79% (b) Gross Profit using the percentage-of-completion method Gross Profit Project B Construction Financial Management: Answers to Exercise Questions Exercise Questions for Chapter Exercise Questions for Chapter Exercise Question Base on the Income Statement and the Balance Sheet shown on Tables 2.1 and 2.2 respectively in Chapter Calculate: a) the three Profitability Ratios, b) the three Liquidity Ratios, c) the three Working Capital Ratios, d) the two Capital Structure Ratios, and e) the seven Activity Ratios Solution: (a) Profitability Ratios Profitability ratios measure the construction company’s ability to earn profit from its operation The three most commonly used profitability ratios are: Gross Profit Margin Ratio = Gross profit / Revenue For 2012, 9,921,256 / 40,875,351 = 24.27% For 2011, 10,319,606 / 34,701,250 = 29.74% (The goal for net profit margin ratio is 25% minimum; if subcontractors (pay-as-paid basis) occupy a significant portion of the cost of revenue, the goal can be reduced to 20% minimum) Net Profit Margin Ratio = Net profit before tax / Revenue For 2012, 1,333,440 / 40,875,351 = 3.26% For 2011, 2,814,730 / 34,701,250 = 8.11% (The goal for net profit margin ratio is 5% minimum) Return on Equity Ratio = Net profit before tax / Owners’ equity For 2012, 1,333,440 / 5,431,345 = 24.55% For 2011, 2,814,730 / 5,694,202 = 49.43% (The return on equity ratio should be between 15% and 40%) Download free eBooks at bookboon.com Construction Financial Management: Answers to Exercise Questions Exercise Questions for Chapter (b) Liquidity Ratios Liquidity ratios indicate the construction company’s ability to pay its obligations as they come due The three most common liquidity ratios used are shown below Current Ratio = Current assets / Current liabilities For 2012, 12,697,745 / 7,679,247 = 1.65 For 2011, 11,685,952 / 6,177,005 = 1.89 (The current ratio should be higher than 1.3 for a financially healthy construction company) Acid Test Ratio (or Quick Ratio) = (Cash + Accounts receivables) / Current liabilities For 2012, (2,305,078 + 6,124,992) / 7,679,247 = 1.10 For 2011, (1,877,676 + 5,837,658) / 6,177,005 = 1.25 (The acid test ratio or quick ratio should be higher than 1.1 for a construction company) Current Assets to Total Assets Ratio = Current assets / Total assets For 2012, 12,697,745 / 14,591,105 = 87.02% For 2011, 11,685,952 / 13,772,652 = 84.85% (The current assets to total assets ratio should be between 60% and 80%) (c) Working Capital Ratios These ratios measure how well the construction company is utilizing its working capital The three most commonly used working capital ratios are shown below Working Capital Turnover = Revenue / Working capital For 2012, 40,875,351 / (12,697,745 – 7,679,247) = 8.14 times For 2011, 34,701,250 / (11,685,952 – 6,177,005) = 6.30 times (The working capital turnover should be between and 12 times per year) Net Profit to Working Capital Ratio = Net profit before tax / Working capital For 2012, 1,333,440 / (12,697,745 – 7,679,247) = 26.57% For 2011, 2,814,730 / (11,685,952 – 6,177,005) = 51.09% (The net profit to working capital ratio should be between 40% and 60%) Download free eBooks at bookboon.com Construction Financial Management: Answers to Exercise Questions Exercise Questions for Chapter Degree of Fixed Asset Newness = Net depreciable fixed assets / Total depreciable fixed assets For 2012, 1,893,360/ 3,945,260 = 47.99% For 2011, 2,086,700/ 3,750,100 = 55.64% (The degree of fixed asset newness should be between 40% and 60%) (d) Capital Structure Ratios Capital structure ratios indicate the ability of the construction company to manage liabilities These ratios also indicate the approach that the company prefers to finance its operation The two major capital structure ratios are: Debt to Equity Ratio = Total liabilities / Owners’ equity For 2012, 9,159,760 / 5,431,345 = 1.69 For 2011, 8,078,450 / 5,694,202 = 1.42 (The debt to equity ratio should be lower than 2.5) Leverage = Total assets / Owners’ equity For 2012, 14,591,105 / 5,431,345 = 2.69 For 2011, 13,772,652 / 5,694,202 = 2.42 Download free eBooks at bookboon.com Click on the ad to read more Construction Financial Management: Answers to Exercise Questions Exercise Questions for Chapter Or Leverage = Total assets / Owners’ equity = (Total liabilities + Owners’ equity) / Owners’ equity = (Total liabilities / Owners equity) + = Debt to Equity Ratio + For 2012, 1.69 + = 2.69 For 2011, 1.42 + = 2.42 (The leverage should be lower than 3.5 Some construction companies prefer to use leverage of 3.5 or close to it but some conservative ones prefer to use a lower leverage This relates to, of course, the use of a higher or lower debt to equity ratio by the company.) (e) Activity Ratios Activity ratios indicate whether or not the construction company is using its assets effectively, and if yes, how effective they are There are quite a number of activity ratios, and the seven commonly used ones are shown below Average Age of Material Inventory = (Material inventory / Materials cost) × 365 days For 2012, (942,765 / 20,732,506) × 365 = 16.60 days For 2011, (761,763 / 15,925,567) × 365 = 17.46 days (The average age of material inventory should be shorter than 30 days) Average Age of Under Billings = (Under billings / Revenue) × 365 days For 2012, (581,221 / 40,875,351) ×365 = 5.19 days For 2011, (486,472 / 34,701,250) × 365 = 5.12 days (The average age of under billings should be the shorter the better) Average Age of Accounts Receivable = (Accounts receivable / Revenue) × 365 days For 2012, (6,124,992 / 40,875,351) × 365 = 54.69 days For 2011, (5,837,658 / 34,701,250) × 365 = 61.40 days (The average age of accounts receivable should be shorter than 45 days) Download free eBooks at bookboon.com 10 - (2) where Pn is the unpaid principal at the beginning of period n, and A is the final payment at the end of period n, which consists of the interest (iPn) and the unpaid principal Pn in that period Hence, the unpaid principal (Pn-1) at the beginning of period n-1 can be calculated as follows: Pn-1 = Pn + (A – iPn-1) (3) Note that iPn-1 and (A – iPn-1) equal the interest payment and the principal amortization respectively paid at the end of period n-1 Substituting (2) into (3) and by algebraic transformation, we obtain: Pn-1 $ 1  L + $ 1  L - (4) Download free eBooks at bookboon.com 19 Construction Financial Management: Answers to Exercise Questions Exercise Questions for Chapter Similarly, the unpaid principal at the beginning of period n-2 is: Pn-2 = Pn-1 + (A – iPn-2) - (5) where iPn-2 and (A – iPn-2) equal the interest and the principal amortization paid at the end of period n-2, respectively Substituting (4) into (5), we have: Pn-2 $ 1  L + $ $ + 1  L 1  L (6) So, we continue to find the earlier unpaid principals, and we can finally obtain the unpaid principal at the beginning of period 1: P1 $ 1  L + $ $ $ + « 1  L 1  L 1  L Q - (7) From Eq 3.7 of Chapter 4, (7) can also be written as: ª 1  L Q  1º Q » ¬ L1  L ẳ P1 = A ì ô (8) We can observe that (8) is identical to (1), and (8) is derived from (1) Since we have derived (8) based on the assumption that the remaining principal at the end of period n is zero, the proof is thus completed Note The above proof also proves that the total amortization (sum of all amortizations) is equal to the principal amount P1 Download free eBooks at bookboon.com 20 Construction Financial Management: Answers to Exercise Questions Exercise Questions for Chapter Exercise Questions for Chapter Exercise Question An appraisal of three alternative investments, A, B and C is being made and the minimum desirable rate of return is 10% p.a on its invested capital The details of the investments are shown below Investment A Investment B Investment C Initial cost $900,000 $1,600,000 $3,100,000 Salvage value Nil Nil $300,000 Net annual income $368,000 $612,000 $846,000 Life years years years a) Find the IRR of each investment b) Find the NPV of each investment Compare the ranking with (a) above c) Use the Incremental IRR method to determine which investment is the best to invest DTU Summer University – for dedicated international students Application deadlines and programmes: Spend 3-4 weeks this summer at the highest ranked technical university in Scandinavia DTU’s English-taught Summer University is for dedicated international BSc students of engineering or related natural science programmes 31 15 30 March Arctic Technology March & 15 April Chemical/Biochemical Engineering April Telecommunication June Food Entrepreneurship Visit us at www.dtu.dk Download free eBooks at bookboon.com 21 Click on the ad to read more Construction Financial Management: Answers to Exercise Questions Exercise Questions for Chapter Solution: (a) The NCF, IRR and IRR ranking of each investment: End of year Investment A Investment B Investment C -900,000 -1,600,000 -3,100,000 368,000 612,000 846,000 368,000 612,000 846,000 368,000 612,000 846,000 368,000 612,000 846,000 IRR 1,146,000 23.06% 19.48% 13.49% 2nd 3rd Investment A Investment B Investment C NPV 266,510 339,958 293,282 Ranking 3rd 1st 2nd Ranking 1st (b) The NPV and NPV ranking of each investment (c) The Incremental IRR Analysis First, compare Investment A and Investment B: End of year Incremental IRR NCF of A NCF of B B minus A -900,000 -1,600,000 -700,000 368,000 612,000 244,000 368,000 612,000 244,000 368,000 612,000 244,000 368,000 612,000 244,000 = 14.76% p.a > 10% p.a So, B is better than A A is out Download free eBooks at bookboon.com 22 ...S.L Tang Construction Financial Management Answers to Exercise Questions Download free eBooks at bookboon.com Construction Financial Management: Answers to Exercise Questions... project Download free eBooks at bookboon.com Construction Financial Management: Answers to Exercise Questions Exercise Questions for Chapter Project Financial data Project A Project B Contract... eBooks at bookboon.com Construction Financial Management: Answers to Exercise Questions Exercise Questions for Chapter (b) Liquidity Ratios Liquidity ratios indicate the construction company’s